Investment process: Bottom-up, focused on quality
The investment process emphasises proprietary bottom-up research. GSS is well-resourced, and the managers have the capacity for this in-depth approach. The portfolio has around 130 holdings, and each manager has responsibility for around 10-15 stocks. Each stock has a portfolio manager, and a designated back-up manager. In addition to company visits, the team may also engage with suppliers, competitors and customers, as well as industry experts, to build a more insightful picture of a company’s strengths and weaknesses. The analysis involves a detailed and common valuation model, where the yardstick is the five-year annualised expected return, expressed in US dollars, to allow the team to compare all stocks under coverage. Prior to the purchase of a stock, a mandatory written investment case is circulated among portfolio managers, to encourage challenge and knowledge sharing.
Companies are assessed for quality and given a rating to indicate a business’ ability to generate sustainable excess returns on capital, and the resilience of its intrinsic value in US dollar terms. Environmental, social and governance (ESG) considerations are integrated into this assessment, which ranks a company’s quality on a scale from A to C. The highest rank is A, and these companies tend to have very high and sustainable barriers to entry (for example Dutch brewer Heineken, and Hong Kong-listed insurance company AIA). C-ranked companies in the portfolio may include good businesses that are operating in a less stable environment (for example Garanti Bank, which operates in Turkey where geopolitical risk is high), or stocks that present compelling valuation after an unjustifiable correction. The rankings influence a stock’s weighting in the portfolio, with high-quality companies (As and Bs) typically having larger position sizes. Other factors are also considered, including the liquidity of a stock, and also the portfolio manager’s familiarity with the company (thus newly listed companies are likely to be a smaller holding). The portfolio is most heavily represented by A and B companies, and typically, will hold less than 25% in C companies. Because the manager looks to invest in companies that can return good capital growth, but also focuses on entry-points that offer a discount to a stock’s intrinsic value, GSS tends to have both growth and value characteristics.
The average holding period of investments has consistently been around five years. Many stocks have been held for longer and the manager is comfortable buying relatively illiquid stocks, building positions gradually. Smaller capitalisation stocks with strong investment cases can offer particularly attractive long-term returns, and liquidity tends to improve as the merits of these undiscovered stocks become better appreciated.
Risk is managed a number of ways. The investment process ensures the portfolio is diversified and, as at end-August 2018, was invested across 35 countries and 10 sectors. The maximum permitted exposure to any single country or sector is 25%. Risk is also mitigated through the portfolio’s focus on quality companies at reasonable valuations, and the team’s in-depth knowledge of the holdings. A portfolio coordination team (PCT), consisting of three team members, ensure the integrity of the investment process and monitor the portfolio with regard to its exposure and risk profiles.
Current portfolio positioning
As shown in Exhibit 5, GSS’s largest exposures are to the consumer (35.1%) and financials (28.6%) sectors, which are long-held, structural overweight positions. This reflects the manager’s view that one of the compelling drivers of emerging markets equities is rising income, and growth of a large middle-class. The portfolio is 19.5pp overweight to the consumer sector, and has a significant exposure to ‘baijiu’ liquor companies in China, including Jiangsu Yanghe Brewery (JYB). JYB is the country’s largest baijiu producer and an industry consolidator. Its products span a broad range of retail prices, with premium brands commanding prices of around US$200 per bottle. Barriers to entry are high as many of the sought after qualities are unique, including the location where the grains are produced, the recipe, and the characteristics of the underground ‘pit’ in which the spirit is aged. JYB’s range of products include premium leading brands, standing to benefit as rising incomes allow middle-class consumers to upgrade to more prestigious labels. Modest capital expenditure needs, net cash and the ability to expand already generous margins support a free cash flow yield of over 5%, which the manager believes can continue to increase. GSS also recently purchased Colgate-Palmolive. Although US-listed, emerging markets countries account for over half of its revenue, and most of its expected growth. The company has strong market positions with around 70% share in Latin America, 50% in India and 30% in China. Following a period of underperformance, the stock’s valuation came back a level the manager considered attractive, with a free cash flow yield of over 5%.
Financials is the second largest exposure in the portfolio, and is 5.4pp overweight relative to the benchmark. However, while the benchmark’s sector constituents are dominated by large cap banks (with several mega-caps in China), GSS’s holdings are focused on smaller banks in early-stage economies. In these markets, banks’ businesses are predominantly local, and relatively insulated from global competition, benefiting from low cost ‘sticky’ deposits, healthy margins and balance sheets. Leading banks in these markets often have high barriers to entry (including customer loyalty and limited access to capital for challengers) and are well-placed to benefit from improving financial penetration. Credit growth can outstrip GDP growth for many years. The portfolio’s holdings include Bank Central Asia (Indonesia), Kotak Mahindra Bank (India) and recently purchased HDFC, one of India’s largest mortgage finance companies. GSS also holds Sberbank in Russia and Garanti Bank. in Turkey. These latter two banks are considered to have good quality franchises, however the stocks have been heavily sold-off recently, partly reflecting escalating geopolitical tensions with the US, and investor concerns over the countries’ economic stability.
Exhibit 5: Portfolio sector exposure vs benchmark (% unless stated)
|
Portfolio end- September 2018 |
Portfolio end- September 2017 |
Change (pp) |
Index weight |
Active weight vs index (pp) |
Trust weight/ index weight (x) |
Consumer |
35.1 |
31.1 |
4.1 |
15.6 |
19.5 |
2.3 |
Financials |
28.6 |
27.1 |
1.5 |
23.2 |
5.4 |
1.2 |
IT |
18.1 |
16.1 |
2.1 |
26.9 |
(8.8) |
0.7 |
Healthcare |
5.0 |
6.2 |
(1.3) |
3.0 |
1.9 |
1.6 |
Real Estate |
2.8 |
2.6 |
0.2 |
2.8 |
0.1 |
1.0 |
Materials |
2.5 |
4.4 |
(1.8) |
7.9 |
(5.4) |
0.3 |
Telecoms |
2.4 |
4.1 |
(1.7) |
4.5 |
(2.1) |
0.5 |
Industrials |
1.1 |
1.5 |
(0.5) |
5.4 |
(4.4) |
0.2 |
Investment Companies |
0.9 |
1.1 |
(0.2) |
0.0 |
0.9 |
N/A |
Energy |
0.6 |
3.7 |
(3.1) |
8.2 |
(7.6) |
0.1 |
Utilities |
0.0 |
0.2 |
(0.2) |
2.4 |
(2.4) |
0.0 |
Cash |
2.8 |
1.9 |
0.8 |
0.0 |
|
|
|
100.0 |
100.0 |
|
100.0 |
|
|
Source: Genesis Emerging Markets Fund, Edison Investment Research
The portfolio is most underweight information technology (IT), where the manager often struggles to find attractive stocks. This sector is dominated by China internet stocks and technology hardware manufacturers, which are very large cap, and widely-owned names. The manager finds many of the internet stocks to be unattractive on valuation grounds, while it has turned cautious on the industry cycle for the hardware manufacturers. Exhibits 6 and 7 show the portfolio’s geographical exposures. GSS’s 18.5pp underweight to Asia is fairly evenly reallocated to the other regions, and the manager expects this to be a typical stance, in part due the commitment to a diversified portfolio. Asia’s weight in the MSCI Emerging Markets index is 74.6%, and China alone accounts for 31.0%, followed by the two relatively developed countries of South Korea and Taiwan. These countries are natural underweight positions for the manager, which tends to find the most interesting investment opportunities in less mature markets, outside of the state-owned enterprises (SOEs), and in companies that are less well-researched.
Exhibit 6: Portfolio top 10 country exposure (% unless stated)
|
Portfolio end- September 2018 |
Portfolio end- September 2017 |
Change (pp) |
Index weight |
Active weight vs index (pp) |
Trust weight/ index weight (x) |
China |
19.5 |
17.1 |
2.4 |
31.0 |
(11.5) |
0.6 |
India |
10.9 |
10.7 |
0.2 |
8.5 |
2.4 |
1.3 |
South Korea |
9.7 |
10.3 |
(0.6) |
14.9 |
(5.2) |
0.7 |
South Africa |
8.0 |
9.0 |
(1.0) |
6.1 |
1.9 |
1.3 |
Brazil |
5.9 |
6.2 |
(0.3) |
6.2 |
(0.3) |
1.0 |
Russia |
4.8 |
6.7 |
(1.9) |
3.7 |
1.1 |
1.3 |
Thailand |
4.6 |
4.6 |
0.0 |
2.5 |
2.1 |
1.8 |
Mexico |
4.1 |
3.3 |
0.8 |
3.2 |
0.9 |
1.3 |
Taiwan |
3.4 |
4.1 |
(0.7) |
12.3 |
(8.9) |
0.3 |
Turkey |
2.7 |
3.0 |
(0.3) |
0.6 |
2.1 |
4.5 |
Other |
23.6 |
23.1 |
0.5 |
11.0 |
12.6 |
2.1 |
Cash |
2.8 |
1.9 |
0.9 |
0.0 |
|
|
|
100.0 |
100.0 |
|
100.0 |
|
|
Source: Genesis Emerging Markets Fund, Edison Investment Research
Exhibit 7: Portfolio regional exposure* (% unless stated)
|
Portfolio end- September 2018 |
Portfolio end- September 2017 |
Change (pp) |
Index weight |
Active weight vs index (pp) |
Trust weight/ index weight (x) |
Asia |
56.1 |
52.6 |
3.5 |
74.6 |
(18.5) |
0.8 |
Middle East/Africa |
14.0 |
16.4 |
(2.4) |
7.8 |
6.1 |
1.8 |
Americas |
15.2 |
14.4 |
0.8 |
11.3 |
3.9 |
1.3 |
Europe/Central Asia |
14.8 |
16.6 |
(1.9) |
6.3 |
8.5 |
2.3 |
|
100.0 |
100.0 |
|
100.0 |
|
|
Source: Genesis Emerging Markets Fund, Edison Investment Research. Note: *Adjusted for cash.
GSS is consistently and meaningfully underweight SOEs, currently by around 16pp relative to the benchmark, representing one of the largest ‘bets’ in the portfolio. The manager believes SOEs often have dual mandates, both economic and political, that may result in investment and operating decisions that do not benefit the minority shareholders. For example, the team finds China Mobile’s capital expenditure to be very aggressive, despite having a relatively mature business, and ascribe it to the company’s significant investment in 5G telecommunications technology. The Chinese government has made it their political priority to be the global leader in this field. GSS is also underweight the energy and materials sectors, where SOEs are prevalent.
GSS’ exposure to non-index frontier markets was around 6% as at end-August 2018, including Vinamilk, the largest dairy company in Vietnam; and Dangote Cement, the largest cement producer in Nigeria. As at end-August 2018, the portfolio overlapped with the constituents of MSCI Emerging Market index benchmark by less than 25%.